Unit 8: Fiscal Policy
How a government's own taxing and spending can be used to shrink a recession or cool an overheated economy.
6 topics · 18 questions
Each topic is a path, not a menu: work down it in order and every question builds on the one above. Click any of them to watch the answer draw itself.
Government Spending and Taxation as Policy Tools
- How it worksHow does fiscal policy use changes in government spending and taxation to shift total demand in the economy?
- Common mistakeWhy isn't fiscal policy the same thing as monetary policy set by a central bank?
- Going furtherWhat happens to the size of fiscal policy's tools during a war compared with peacetime?
Your turn1 of 2
Why does a government have exactly two levers, spending and taxes, to try to steer the whole economy?Expansionary Fiscal Policy in a Recession
- How it worksHow does expansionary fiscal policy raise spending or cut taxes to push aggregate demand higher during a recession?
- Worked exampleFind the direction output and the price level move after a 300 billion dollar rise in government spending during a recession.
- Common mistakeWhy doesn't every dollar of a tax cut during a recession get spent by the household that receives it?
Your turn1 of 2
During a recession, the government raises spending by 300 billion dollars. Why would a government spend more money and cut taxes at the exact moment it's collecting less revenue?Contractionary Fiscal Policy to Cool Inflation
- How it worksHow does contractionary fiscal policy cut spending or raise taxes to pull aggregate demand back down during high inflation?
- Common mistakeWhy isn't contractionary fiscal policy just austerity for its own sake?
- Going furtherWhat happens to unemployment in the short run when contractionary fiscal policy is used to fight inflation?
Your turn1 of 2
Why would a government deliberately cut its own spending while the economy still looks strong?The Multiplier Effect
- How it worksHow does each round of new spending becoming someone else's income create the multiplier effect?
- Worked exampleFind the spending multiplier and the total change in GDP when the marginal propensity to consume is 0.8 and government spending rises by 100 billion dollars.
- Common mistakeWhy isn't the multiplier effect infinite even though the spending keeps getting re-spent?
Your turn1 of 2
The marginal propensity to consume is 0.779. Government spending rises by 147 billion dollars. Using the spending multiplier, what is the total change in GDP?Budget Deficits and the National Debt
- How it worksHow does each year's budget deficit add onto the accumulated total that becomes the national debt?
- Worked exampleFind the national debt after three straight years of 500 billion dollar deficits starting from 25 trillion dollars.
- Common mistakeWhy isn't a budget deficit the same thing as the national debt itself?
Your turn1 of 2
A country starts with a national debt of 29 trillion dollars. It then runs a budget deficit of 589 billion dollars in each of the next 5 years. What is the national debt after those years?Automatic Stabilizers
- How it worksHow do progressive taxes and unemployment benefits act as automatic stabilizers that cushion the business cycle without new legislation?
- Common mistakeWhy aren't automatic stabilizers the same thing as a deliberate fiscal policy decision by Congress?
- Ties togetherHow do automatic stabilizers soften the multiplier effect's swings during a recession without Congress passing any new law?
Your turn1 of 2
Why does government spending on unemployment benefits rise automatically the moment a recession hits, with no new law required?